Stock markets: where have the good times gone?

The Big Read: Bankers kept out of the bull run

Nearly six years after it started, the bull market is in full swing, with stocks across the world smashing new records last week. In the US, the S&P 500 set a new all-time high, pushing its returns since the depths of the global financial crisis to almost 250 per cent. European markets have got in on the act, too, with the FTSE-All World index setting a record. Most impressively, the FTSE 100 in the UK touched a new high for the first time since 1999.

But the contrast with the bull run of the late 1990s, when each new landmark was greeted with commemorative T-shirts and free-flowing bubbly, could not be greater.

On Wall Street, it has become commonplace to call this bull market "the most hated rally in history". And in the City of London, bankers with long memories say the mood in dealing rooms is nothing like the optimism and euphoria of past rallies.

"It's not an exuberant market," says a senior equities banker in the City, pointing out that new equity issuance from companies remains well off its highs.

Good news in the stock markets has typically meant good times for bankers. But the hot streak has come in the midst of another disappointing bonus season for investment bankers, tempering the mood and reflecting larger changes that have kept big banks from enjoying the benefits of a strong equity market.

Post-crisis regulations have capped the fees banks can charge for trading stocks. Their profits have been squeezed by regulations that require them to hold more capital as a buffer against another financial crisis. And years of post-crisis retrenchment, along with structural changes to trading businesses, have transformed the landscape. "From 1999 to now there has been a massive change," says Nick Lawson, managing director at Deutsche Bank. "When the last high was hit . . . trading floors were still buzzing with young men in jeans determined to make their mark on the world and give up work by 40".

Mr Lawson remembers being in the dealing room the day the previous high for the FTSE 100 was hit, on December 30 1999. "People were acutely aware of it," he says, adding that 20 people traded UK equities for Deutsche back then.

Today, their number has been reduced to just two. "Dealing rooms are more sober places," Mr Lawson says.

The Wall Street bonus pool this year was about 5 per cent smaller than 2014, says Alan Johnson, managing director at Johnson Associates, a pay consulting group. Shrinking bonuses could prompt more senior bankers to try their luck in private equity or hedge funds. "Six or seven years on from the crisis, business hasn't got back to 'good,' never mind the euphoria of 2007," he says.

Fred Ponzo, founder of Greyspark Partners, a capital markets consultancy, says the banking industry "is pretty much run now as a utility".

"Once you have the structure in place you don't need to spend massively on the people running it. That's the big transformation," he adds. "People are not getting big bonuses because they don't do anything to deserve them. The machine is taking care of it."

Bankers' bonuses have also fallen in Europe as banks adjust to new rules that cap bonuses at twice the salary for senior bankers and risk-takers. "It's tough [telling people], but if you'd done a reasonable job of expectation management, people were largely prepared," says one managing director.

Perhaps most significantly for investment bankers, there has been a fundamental shift in earning power from the big banks, such as HSBC and JPMorgan Chase, to the big asset managers such as BlackRock. Their pay is due to overtake that of investment bankers next year, a remarkable sign of how the balance of power in financial services has changed.

According to the London think-tank New Financial, pay per employee at investment banks has dropped by more than a quarter since before the financial crisis and by more than 40 per cent in real terms. Meanwhile asset managers' pay has fully recovered after the end of the crisis and, at £263,000 per person, is on course to overtake investment bankers' £288,000.

"They have the juice now," says a former credit trader at a large US bank, using Wall Street slang to indicate that asset managers are now dominating the business of buying bonds.

But asset managers' dominance conceals a big problem for the sector: this has been a difficult rally for professional investors, too. Fund managers who actively trade stocks have been deeply frustrated by the uniform nature of the rally. All buoyed by the Fed, the returns on stocks have barely varied. Meanwhile, sectors are also far less linked than they used to be - so there is no reward for investors rotating in and out of specific groups through the course of a market cycle.

"That classic paradigm has not worked, financials for example have lagged,'' says Nicholas Colas, chief market strategist at Convergex, a brokerage and services provider. "And that has made active managers, who are the voice of the market, very frustrated."

According to Standard & Poor's, dispersion - a measure of how much the moves of stocks in the S&P 500 vary from each other - touched a historic low of 4.2 per cent last year. It has been as high as 15 per cent in the past. That means there have been no gains for people who try to spot cheap stocks, either.

The odd nature of this rally has ensured that very few actively managed funds have managed to match their benchmark, let alone beat it. Clients have noticed this, and have started to pull money from active funds and move into rival index funds - which charge lower fees, and in general employ fewer people at less exciting salaries.

The phenomenon extends to hedge funds, which have also lagged miserably during this rally, and to other alternative asset classes such as private equity. Preqin, a consultancy, found that investors in all the major alternative asset classes were concerned about fees and trying to push them down. Infrastructure, a popular asset class at present because it offers an income, has provoked a particularly strong reaction from investors, who claimed that its backers were attempting to extract hedge fund-like return fees.

Asset management fees are under pressure on both sides of the Atlantic. Big pension funds in particular are demanding fee discounts from fund managers before they give them their business.

Fees also face increasing regulatory scrutiny. In the UK, the Financial Conduct Authority said last month that it was considering an investigation into asset managers' fees - and many business organisations cheered the news. In the US, the White House launched a fresh attempt to clamp down on commissions for advisers selling pensions.

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Kenneth Polcari, director of NYSE floor trading at O'Neil Securities, says: ''There is a disconnect between what the market is telling us and how the average person feels about the economy. With the market at an all-time high, it suggests the economy is firing on all eight cylinders.

Back in 2000, the economy and the job market were in a different place and there was a feeling of euphoria that is missing today.''

Many of those who have bought stocks say they did so only because the US Federal Reserve and other central banks gave them no choice. The fear is widespread that the market - and the economy - will not be able to survive interest rates' return to normality.

Mr Colas says a common refrain among their clients is that the bull market run feels artificial thanks to central bank policy. "There is a belief that the market rally has been fuelled by central banks and not by organic growth and rising revenues," says Mr Colas.

Record profits at S&P 500 companies have been boosted by aggressive cost-cutting, while revenue growth remains anaemic. Aggressive stock buybacks have also pushed up equity prices, with companies such as Apple issuing debt at record low yields and using the proceeds to fund dividend payouts and return cash to shareholders. Such strategies imply a continuing lack of capital investment, and suggest the strong returns are based more on financial engineering than anything else.

Another concern has been the decline in bond yields, which are now negative in several European countries. This means that future cash flows are being discounted at lower rates, adding to the sense of artifice about valuations, says Mr Colas.

<>Concerns about the fundamental drivers of the market rally may have scared off "Main Street" investors, who have by now missed out on big gains. Others may have been unable to invest as they focused on repairing their finances after the recession.

Mr Polcari says the brutal drop in equities during the financial crisis has also scarred a generation of investors and the pain of that memory will take a long time in fading.

If there is another reason to peg back enthusiasm, it comes from the US. It has led other major stock markets throughout this rally, but in the past few weeks concerns have grown that this cannot last. That is mainly because of the Fed, but also because economic data - apart from the labour market figures - have been poor. Expectations for S&P companies' profits have collapsed.

Paradoxically, all this pessimism may be good news for the stock market. BofA Merrill Lynch's monthly survey of global fund managers finds that equity funds have more than 4.5 per cent in cash - a number that in the past has worked as a contrarian indicator. When funds hold this much cash, it is generally a sign that markets are heading up.

The dearth of retail investors is also a sign that the market has yet to peak. Typically, they need to be pulled in before the market can start to fall.

And finally, Europe appears to be taking over the reins from the US. Analysts say profits will rise this year, and the market has just dodged a bullet with the temporary resolution of the crisis over Greek debt. Bond purchases from the European Central Bank will help too. "This is a market that has clearly not finished going up," says Mr Colas. "Where the US dragged other markets higher in recent years, it looks like Europe is now pulling US equities higher."

So even if the rally still has longer to go, a return to 1999-style euphoria appears a long way off. "It was completely different in 1999," says a UK head of investment banking. "There are way more regulations, there are even more competitors and there are fewer people working in banks so that means we are all doing more work."

"The regulatory straitjacket has meant that the brightest people don't go into banking any more. I wouldn't recommend my kids to go into it."

Additional reporting by Laura Noonan, Tracy Alloway, Arash Massoudi and Ben McLannahan

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